By Sabrina Karl
Usually when we buy insurance, we’re protecting ourselves against an otherwise devastating financial loss, such as the cost to replace a home or vehicle, or the cost of medical bills should we become seriously ill or injured. But for homeowners buying private mortgage insurance, it’s not about protecting yourself.
Often called PMI, private mortgage insurance is actually an insurance policy for mortgage lenders, even though homeowners pay the premium. It financially protects the lender from losing money should the homeowner default on their mortgage. And for certain homebuyers, it’s not optional.
Any buyer who takes out a conventional mortgage with a down payment of less than 20 percent is required to hold PMI. That’s because mortgage statistics show that the less equity a homeowner has in their property, the higher their risk of default. Once equity surpasses 20 percent, the risk of foreclosure drops significantly.
Private mortgage insurance is most commonly handled as a monthly premium bundled with the mortgage payment. However, some lenders offer an option to pay for PMI in one lump sum at closing, or in a combination of upfront and monthly payments.
PMI costs vary based on two main factors: the borrower’s credit rating and the amount of their down payment. Costs typically range from 0.5% to 1.0% of the original loan amount per year. So for a $200,000 mortgage, PMI would likely cost $1,000 to $2,000 annually, or $83.33 to $166.66 a month.
To avoid this monthly add-on, some homebuyers will save longer before buying so they can swing a 20 percent down payment, while others opt for FHA or other non-conventional mortgages that don’t require PMI. But these mortgages can carry higher rates, and waiting to purchase isn’t always desirable. So PMI offers homebuyers an option that they can weigh against the alternatives.